Most people have a different definition of a comfortable living, so addressing how much you should have in your 401k is not a simple black and white answer — this amount will vary based on age, lifestyle, and finances. However, as a good rule of thumb, many experts recommend saving one year of salary for every five years of age.
While personal savings is personal, the idea of a “nest egg” will make you contemplate what your financial future holds. Retirement might seem like a long way down the road, but time flies faster than we realize. If you’re fortunate to have an employer who offers a 401k account, consider taking advantage and start saving for retirement as early as possible.
What is a 401k?
A 401k is an employer-sponsored savings plan that allows workers to set aside a portion of their paycheck for retirement. Named after a section of the Internal Revenue Code, 401k plans are an easy way to save for the future because the money is automatically deducted from your paycheck. Many retirees count on Social Security to cover their living expenses after the working years, but these benefits are often not enough to sustain seniors without an additional income. If your employer offers a 401k plan, this may be an excellent way to start saving for retirement and lighten the burden of doing it alone.
Benefits of Having a 401k
Different 401k plans come with different perks, each with unique advantages.
Tax advantages: Traditionally, the savings in your 401k account is pre-tax. This means that the amount you contribute is exempt from current federal income tax, which also lowers your taxable income. In this case, you don’t have to pay tax on the funds until you actually withdraw them. Since most people are in a lower tax bracket during their retirement years, this may lower the amount they pay in taxes on 401k withdrawals. However, depending on the type of plan you have, the tax break can come when you contribute money (Roth 401k) or withdraw funds during retirement (traditional 401k).
Employer matching contributions: In some cases, employers will offer to match the amount you put into your 401k, which is essentially free money! Employers might offer a certain percentage of what you contribute or even dollar-to-dollar matching. Consider saving up to the maximum annual contribution amount because employer contributions don’t count towards your annual limit.
Lifetime contributions: In the case of some retirement accounts and IRAs, there is often an age limit for contributions. However, 401k accounts are not subject to this stipulation so you can contribute funds as long as you are working.
Automatic investment: For many, 401k plans may be the easiest way to save for the future because they automatically deduct funds from your paycheck and place them in the account. This way you don’t have to think twice about your savings.
How Much Do You Need to Retire Comfortably?
Planning for retirement takes work, and unfortunately, many Americans are woefully under-prepared when it comes to the state of their savings. What you need to retire isn’t about hitting a specific dollar amount, instead, you’ll want to be able to replace enough of your income to live comfortably. This suggestion isn’t black and white because the standard of living looks different for each individual — consider what it takes to live comfortably and maintain your lifestyle. Many experts suggest that you’ll need roughly 80% of your salary after retirement to avoid making sacrifices.
Create a post-retirement budget based on the lifestyle you’d like to maintain. This will serve as a guideline that determines how much you might spend when you retire. In some cases, it may be beneficial to seek financial advice to make sure you are planning accordingly. Most people hope to enter their retirement years debt free, but for some, this won’t be the case. You may need to consider these expenses:
- Monthly debt payments
- Unexpected medical expenses
- Replacement vehicles or repair
- Miscellaneous expenses like travel
What role will Social Security play in your income? Generally speaking, Social Security is designed to replace about 40% of the average senior’s income. If you’ll need roughly 80% of your salary to live comfortably, it’s up to you to make up the remaining 40%. This may be where your 401k comes into play.
When to Start Saving for a 401k
Not everyone gets the opportunity to invest in their 401k early on. As soon as it becomes available, consider taking advantage of this benefit. As of 2017, individuals under 49 could legally contribute $18,500 per year. Those 50 years or older, can save an additional $6,000 for a total annual $401k contribution of $24,500.
Many 20-something-year-olds have student debt, changed jobs a handful of times, have not started saving, or are not in a job where a 401k plan is offered. In this case, we’ll look at the amount you should have saved starting at age 30.
A good rule of thumb is to add on one year of salary saved for every five years of age — for example, at age 30 you’d want to have saved one year of salary, at age 35, two years, at age 40, three years, and so on. Use these guidelines along with your post-retirement budget to gauge if you are on track for a comfortable retirement.
By Age 30
By the time you are 30, it’s ideal to have a 401k equal to about one year’s salary — so if you make $50,000 a year, you’d want to have $50,000 saved in your 401k account.
By Age 40
Most people have more stable jobs and have seen an increase in their annual income compared to their 20s. By age 40, three years worth of salary saved in your 401k is a good place to sit, so someone who makes $70,000 a year, should have approximately $210,000 saved in their 401k account.
By Age 50
This is a good checkpoint for your financial future. By age 50, it’s recommended to have roughly five years worth of salary put away. Assuming your annual income has increased to $80,000, this would mean that you’d want to have saved $400,000 in your 401k account.
Is It Too Late to Start Saving?
In a perfect world, you’d start saving in your early 20s. However, personal finances come with their ups and downs, so putting money aside for your 401k is often not a priority or not a possibility. If this is you, consider that it’s never too late to start saving for retirement. While many people aim to retire early, life doesn’t stop at 65, and it’s better to save late than not save at all.
Retirement Savings Tips
Whether you’ve started saving late or are frugal with your finances, there are several things you can do to increase the amount of money you put towards your 401k.
Start living on a budget: Take a look at your retirement budget and lifestyle. Maybe it’s time to adjust your spending habits or cut back on unnecessary spending. Tightening up your budget can free up funds and allow you to save more.
Increase your income: This may be easier said than done especially in your later years. Consider if it’s time for a raise, can you acquire a new set of skills that will increase your annual salary, or are there alternative ways to make a passive income?
Modify your retirement lifestyle: Ask yourself if your retirement budget is realistic. Will you be spending money the same way you are now, or perhaps you’re already retired and can cut back on unnecessary expenses. Whatever the case may be, make sure your lifestyle and finances align.
Pay off high-interest debts: It’s common for people to carry over large debt into their retirement years. High-interest credit cards, personal loans, and lingering student loan debt are types of financial obligations that can keep your hard earned funds tied up and away from your 401k account. Work on tackling early on and as quick as possible.
Compound interest can still work for you: Compound interest is a simple concept that can rapidly cause wealth to snowball. It happens when the interest that accrues to an amount of money, in turn, accrues interest itself. Do your research to see which 401k plans have the best interest bearing options.
Most of us look forward to our retirement years where the money we’ve worked so hard for is now working for us. A 401k is one way to achieve a nest age, so it’s important to take advantage of this benefit if your employer offers it. Planning for a comfortable retirement takes time, due diligence, and budgeting. It’s important to consider your future lifestyle and know where you stand financially, so you don’t have to worry when you reach your golden years. As this material has been prepared for information purposes only, you should consult your tax advisor before making any financial decisions.